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Our last Weekly of 2008 can scarcely be a cheerful one as we look back, although we can take some satisfaction in having warned readers on June 25th of the inevitability of recession resulting from the housing bubble burst, and of the need for flight to absolute safety before the credit crunch really hit (“if ever there were a “capital protection” period, this is it”). The temporary strengthening of the USD took us by surprise, but we alerted readers of its return to a declining trend four weeks ago. Our present stance is to continue recommending profit taking in government bonds and to seek yield in quality corporate bonds in those fields least affected by the recession. |
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We hypothesised last week that the Fed’s main preoccupation is the avoidance of deflation, and that all steps would be taken to avoid it even at the risk of overshooting and creating inflation. Cutting the target interest rate almost to zero is part of that battle. The Fed will now be going on a buying spree to buy all sorts of assets both government and private. The general idea will be to keep the yield curve quite flat so as to encourage borrowing, but which is in direct contradiction with the need to encourage lending by letting banks achieve an attractive spread between their short-term borrowing costs and their returns on longer-term lending. That is as fine a line for Bernanke to follow as that between fleeing deflation but avoiding inflation. |
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The Madoff scandal tops off an already terrible year, and raises serious questions for the future: |
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- How can New York make any claim to being a serious financial centre when the regulation has failed so dismally? The authorities were not only hoodwinked but did not act even when they were warned of problems?
- How will the hedge fund industry cope with “guilt by association” when already politicians are braying for their regulation, and roughly half of the funds are closing down because of losses and redemptions?
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Sarbanes-Oxley was a hastily written law, full of good intentions, but led to a loss of US industrial competitiveness (high compliance costs) and to non-USA corporations spurning New York financial markets in favour of London and Hong Kong. The hedge fund industry has been working on self-regulation, which could have avoided heavy-handed political interference, but it is now too late. Expect another “Sarbanes-Oxley”. |
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In considering how long the recession will last, there is a risk of confusing the repair of the financial markets with the return of US households to sustainable consumption. The former is essential but will not in itself end the recession. No one should forget the cause of the recession: overspending in general and a bursting housing bubble in particular. The recession will be over only when house prices stabilise. While that could happen by mid-2009, it is more likely to be more than a year away. This recession is clearly L-shaped: a decline in GDP and then little growth for many years as US consumption matches its means. |
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Amongst such gloom, there is nevertheless a ray of hope with the change of the US Administration. The least we can say is that the gang who caused the problem are ill-equipped to solve it – any change is therefore welcome. Yet there are positive reasons for hoping that Obama will provide leadership in dealing with the crises. Amongst them is the fact that he values ideas and a thoughtful, reasoned approach to problem-solving. This may be a key turning point in the American people’s attitude to intellect: in recent years any presidential candidate with intellect had to hide it and appear “folksy”. Bush must surely provide evidence of the drawbacks of this route. |
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Many of you will find this Christmas and the Holiday Season a time of regret and reflection. We nevertheless wish you a time of peace, and hope for 2009, and especially that on January 20th, with Obama in the White House, the world may welcome a return to economic and political leadership by a USA associated with modesty and respect. |
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Our next Weekly will appear Wednesday January 7th. |
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Focus |
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(–) Germany: Deutsche Bank has decided not to call its Lower Tier 2 bonds on the five-year call date of January 2009, thereby breaking a long-established market convention. The implications for other banks issuing LT2 bonds are worrying as demand will disappear if calling may no longer be assumed. |
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(–) USA: Madoff Scandal: The list of institutions losing huge amounts is growing, with Geneva institutions (or their clients) exposed to losses of the order of magnitude USD 10 billion |
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(+) USA: the CPI fell more in November than ever before, dropping by 1.7% |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs the question |
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